Should You Buy Whole Life Insurance?

I’ve been getting quite a few questions about life insurance lately. I understand that insurance isn’t exactly the most exhilarating and gripping topic, so this is my attempt to explain the basics of life insurance as simply and briefly as possible.

The purpose of life insurance is to replace an economic loss resulting from the death of an income earner. Unlike other types of insurance, life insurance does not benefit the policyholder. The objective is to provide financially for the people you love in the event of an untimely death.

Who needs life insurance?

Anyone who is financially responsible for others.

The exception is those who have accumulated enough wealth to be self-insured, meaning if they passed away their loved ones could live comfortably on their own personal assets without needing proceeds from a life insurance payout.

Term Life Insurance

There are plenty of options when it comes to getting life insurance, but as with most personal finance decisions, the simpler the better. Term life insurance is the most basic, easy-to-understand, and inexpensive option.

When you buy a term policy you get coverage for a specific period of time (hence the phrase “term”), such as 10, 20, or 30 years. If you happen to die during that time frame, your beneficiaries will receive a tax-free payout based on the coverage amount. If you outlive the term (congratulations), the policy expires and there’s no payout.

The goal is to eventually become self-insured by the time the policy lapses. The amount of life insurance you need goes down as you age, as your kids move out of the house, as you pay off debt, and as you save and build more assets.

Whole Life Insurance

Another type of life insurance is called whole life insurance. It can also be referred to as permanent life insurance, universal life, variable life, variable universal life, indexed universal life, etc., which are all complicated variations of the same type of insurance.

As the name implies, whole life insurance gives you coverage for your entire life—not just a certain period of time. Because the policy covers you for your entire life, the monthly premiums are far more expensive than term life insurance, often up to 15 times more for the same coverage amount.

In addition to death benefit coverage, each policy also comes with a savings or investment component, known as the cash value, which is supposed to grow over time. With term insurance, your entire premium payment goes towards the cost of insurance. However, with whole life insurance, your premium is split between the cost of insurance, the cash value portion, and the commission fees of the agent who sold you the policy.

Unfortunately, only a small amount of that premium payment each month actually goes to build up your cash value. The rest is divided up between the higher cost of insurance and the commission check for the agent. Because the insurance and commission fees are front-loaded on these policies, many policyholders won’t see their cash value amount exceed what they’ve paid in premiums for 10 to 15 years.

That’s 10 to 15 years of zero return on your money. Instead of locking yourself into paying expensive premiums for a poor investment, you could buy a cheap term policy and use the monthly savings to pay off debt, build wealth, or on vacations with family.

Life insurance is good. Investing is good. Mashing them together into one product is completely unnecessary.

Should you buy whole life insurance?

Probably not.

In personal finance, there are no universally right answers that make sense for everyone… but this gets as close as it gets.

How much coverage do you need?

It depends. I’ve seen 10 or 15 times your income as a rule of thumb. You can start by simply asking what your dependents need in the event of your death. Do you want to pay off all of your remaining debt? Fund college expenses? Give them enough to retire?

Here’s a clip of Walter White from Breaking Bad figuring out his own life insurance need:

Getting life insurance is one of those “plug your nose and take your medicine” personal finance tasks. And since none of us like to ponder on death for too long, it also falls under the “important but not urgent” category of tasks that we tend to procrastinate. Yet, it’s an integral part of any financial plan.

Thanks for reading!